lesson 2 - cost, design economics and break-even analysis

7/26/2019 Lesson 2 - Cost, Design Economics and Break-Even Analysis

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EXCELLENCE

Whatever you do, work atit with all your heart, asworking for the Lord, not

for men.

Colossians 3!3 N"#

WE CANT SPELL

S CCESSWITHOUT

U


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Cost, $esignE%onomi%s,

and &reak'Even

(nalysis


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/i0ed Cost

+hese are %osts that are nota1e%ted 2y %hanges in a%tivitylevel over a feasi2le range of

oerations for the %aa%ity or%aa2ility availa2le. +yi%al 40ed%osts in%lude insuran%e and ta0eson fa%ilities, general management

and administrative salaries, li%ensefees, and interest %osts on2orrowed %aital. +hese %osts tendto remain %onstant over a se%i4%range of oerating %onditions.

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2!". E#G$#EE%$#G

E&'#'M, )*T+E. -earson-ren/ice +all. 02)1)


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#aria2le Cost

+hese are %osts asso%iated with anoeration that varies in total with

the 5uantity of outut or othermeasures of a%tivity level. Costssu%h as material and la2or used ina rodu%t or servi%e are varia2le%osts, 2e%ause they vary in totalwith the num2er of outut units,even though the %osts er unit staythe same.




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"n%remental Cost

(lso termed as in%rementalrevenue, it is the additional %ost or

revenue that results fromin%reasing the outut of a system2y one or more units. "t is oftenasso%iated with go'no gode%isions that involve a limited

%hange in outut or a%tivity level.




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EX(-6LE

( new highway is to 2e 2uilt and the

%ontra%tor has a %hoi%e of two sites onwhi%h to setu the ashalt'mi0ing lante5uiment. +he %ontra%tor estimates that itwill %ost 78.89 er %u2i% yard mile to haulthe ashalt'aving material from the mi0ing

lant to the :o2 lo%ation. /a%tors relating tothe two mi0ing sites are as follows

Cost /a%tor *ite ( *ite &

(verage hauling distan%e ; miles auling e0ense 78.89?yd 3'mile 78.89?yd 3'mile

/lagerson not re5uired 7@;?day


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E0amle %ontinued

+he :o2 re5uires 9=,=== %u2i% yard ofmi0ed ashalt'aving material "t isestimated that four months or 8A weeksof 4ve working days er week will 2e

re5uired for the :o2. Comare the twosites in terms of their 40ed, varia2leand total %osts. (ssume that the %ost ofthe return tri is negligi2le. Whi%h is the

2etter siteB /or the sele%ted site, howmany %u2i% yards of aving materialdoes the %ontra%tor have to deliver2efore starting to make a ro4t if aid7.=9 er %u2i% yard delivered to the :o2lo%ationB


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$ire%t Cost

+hese are %osts that %an 2ereasona2ly measured and allo%ated

to a se%i4% outut or worka%tivity. +he la2or and material%osts dire%tly asso%iated with arodu%t, servi%e, or %onstru%tiona%tivity are dire%t %osts. De.g,

materials needed to make a air ofs%issors are dire%t %osts




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"ndire%t Cost

+hese are %osts that are diF%ult toattri2ute or allo%ate to a se%i4%outut or work a%tivity. Normally,

they are %osts allo%ated through asele%ted formula to the oututs orwork a%tivities. De.g, %ost of%ommon tools, general sulies,

and e5uiment maintenan%e.)verhead %onsists of lantoerating %osts that are not dire%tla2or or dire%t material %ost.)verhead and indire%t %osts %an 2e

used inter%hangea2ly.




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*tandard Cost+hese are lanned %osts er unit of outut that areesta2lished in advan%e of a%tual rodu%tion orservi%e delivery. +hey are develoed fromanti%iated dire%t la2or hours, materials, and

overhead %ategories. *tandard %osts lay animortant role in %ost %ontrol and othermanagement fun%tions. *ome tyi%al uses are thefollowing

8. Estimating future manufa%turing %osts

!. -easuring oerating erforman%e 2y %omaringa%tual %ost er unit with the standard unit %ost

3. 6rearing 2ids on rodu%ts or servi%es re5uested2y %ustomers


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Cash Cost

a %ost that involves ayment of%ash and results in a %ash Gow.

these %osts are estimated fromthe erse%tive esta2lished forthe analysis and the futuree0enses in%urred for thealternatives 2eing analyHed.




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&ook Cost

a %ost that does not involve a %ashtransa%tion and is reGe%ted in thea%%ounting system.

also referred to as a non%ash %ost.

+hese are %osts that do not involve%ash ayments 2ut rather reresentthe re%overy of ast e0enditures over

a 40ed eriod of time. +he most%ommon e0amle of 2ook %ost is thedere%iation %harged for the use ofassets su%h as lant e5uiment.Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2!". E#G$#EE%$#G



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*unk Cost

a %ost that has o%%urred in the astand has no relevan%e to estimate offuture %osts and revenues related to

an alternative %ourse of a%tion. +hus,it is %ommon to all alternatives, isnot art of the future %ash Gows, and%an 2e disregarded in an engineering

e%onomi% analysis. these are irretrieva2le

%onse5uen%es of ast de%isions andtherefore are irrelevant in the

analysis and %omarison ofalternatives that a1e%t the future.




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)ortunity Cost

it is a %ost in%urred 2e%ause ofthe use of limited resour%es,

su%h that the oortunity to usethose resour%es to monetaryadvantage in an alternative useis foregone.




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Life'Cy%le

it 2egins with identi4%ation ofthe e%onomi% need or want and

ends with retirement anddisosal of a%tivities.

it is divided in to two generaltime eriods a%5uisition haseand oeration hase.




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"nvestment Cost

is the %aital re5uired for most ofthe a%tivities in the a%5uisition

hase. +his is also known as the

%aital investment.Working Caital

these refers to the funds re5uired for%urrent assets that are needed forthe start'u and suort of

oerational a%tivities.




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)eration and -aintenan%e Cost D)I-

these %osts in%lude many of there%urring annual e0ense itemsasso%iated with the oeration hase ofthe life %y%le.

$isosal Cost

these in%ludes nonre%urring %osts ofshutting down the oeration and theretirement and disosal of assets at

the end of the life %y%le




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&E(J'E#EN (N(LK*"*

Case 8 6ri%e is "ndeendent of$emand



VP

FCBEP

x

=

Where:& 3 4xed

cos/s- 3 sellin50rice6 3 varia7lecos/

P

V

FCBEP

=

1

$

A. &reak'Evenpointin units

&. &reak'Even oint indollars Dmonetary


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Example

A plant produces 15!!! un"ts#mont$%

&"nd 'rea(e)en le)el "* &C + ,-5!!!

#mont$ re)enue "s ,.#un"t and )ar"a'lecost "s ,/%5!#un"t% 0eterm"ne expected

mont$l pro*"t or loss%


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&E(J'E#EN (N(LK*"*

E0amle (n engineering 4rm measures its

outut in a standard servi%e hour unit,whi%h is a fun%tion of the ersonnel

grade levels in the rofessional sta1.+he varia2le %ost is 7;! er standardservi%e hour. +he %harge'out rate is79.9; er hour. +he ma0imum oututof the 4rm is 8;=,=== hours er year,and its 40ed %osts is 7!,=!


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Source: Sullivan, William G., Elin M. Wicks and James T. Luxho.

!"##$%. E&G'&EE('&G E)*&*M+, -T E/. 0earson10rentice all. p"1

2

3reak1Even Anal4sis

)ase ": /emand is a 5unction o6 0rice


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&E(J'E#EN (N(LK*"*

E0amle !.3

( %omany rodu%es an ele%troni% timingswit%h that is used in %onsumer and%ommer%ial rodu%ts. +he 40ed %ost is

7A3,=== er month, and the varia2le %ostis 73 er unit. +he selling ri%e is 78= M =.=!$.

a.$etermine the otimal volume for this

rodu%t and %on4rm that a ro4t o%%ursat this demand.

2./ind the volumes at whi%h 2reakeveno%%urs that is, what is the range of

ro4ta2le demandB

Source: Sullivan, William G., Elin M. Wicks and James T. Luxhoj. (2!". E#G$#EE%$#GE&'#'M, )*T+E. -earson-ren/ice +all. 02)1)


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*E(+W)J O8

6)&LE- O8( large wood rodu%ts %omany isnegotiating a %ontra%t to sell lywoodoverseas. +he 40ed %ost that %an 2e

allo%ated to the rodu%tion of lywood is7@==,=== er month. +he varia2le %ost erthousand 2oard feet is 7838.9=. +he ri%e%harged will 2e determined 2y 7;== M=.=9$ er thousand 2oard feet.

a.What is the otimal monthly salesvolume for this rodu%t and %al%ulate thero4t or loss at the otimal value.

2.What is the ro4ta2le range of thedemand during the monthB


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*E(+W)J O8

6)&LE- O!( lant oeration has 40ed %osts of7!,===,=== er year, and its outut%aa%ity is 8==,=== ele%tri%al alian%es

er year. +he varia2le %ost is 7ow mu%h %aa%ity has 2een usedB

d."f the varia2le %ost is in%reased to 799,

what is the er%ent redu%tion Dorin%rease to the ro4tB What is the

lesson 2 - cost, design economics and break-even analysis

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